Dividend Payer MFA Financial Well Positioned For Rapid Rate Increases

Jun.27.13 | About: MFA Financial, (MFA)

MFA Financial Inc. (NYSE:MFA) is a REIT. It invests in Agency and non-Agency MBS. It is internally managed. It pays a hefty 10.5% dividend, and that is without considering any special dividends. MFA declared a special dividend of $0.50 per common share in March 2013. If you consider this as part of the annual dividend for MFA for 2013, then the annual dividend for FY2013 would be approximately $1.38 per common share (or 16.5%), assuming a continuation of the $0.22 most recent quarterly dividend for the rest of 2013. This last may be an underestimate. The recent mortgage rate raises likely mean that the net interest income (net interest spread) will be greater for the rest of 2013. This means that the dividends paid out by MFA should rise in Q3 and Q4. In other words, the dividends/distributions actually paid in FY2013 will likely amount to 17%-20%. You will need to file a K-1 form for MFA.

MFA is safer than most mortgage REITs in the current rapidly rising mortgage rate environment. It had a total portfolio leverage of only 3.09x as of March 31, 2013. This means its losses due to mortgage and interest rate increases will be much less than primarily Agency RMBS companies such as American Capital Agency Corp. (NASDAQ:AGNC) with leverage of 8.1x and Western Asset Mortgage Capital Corp. (NYSE:WMC) with leverage of 8.7x. MFA does have $7.15B in Agency RMBS (as of March 31, 2013). It does have 7.7x leverage on this. However, this represents only about 25% of MFA's net allocated equity. For WMC and AGNC that figure is roughly 100% (at a high leverage multiple). On top of this MFA had a positive equity gain on its non-Agency portfolio in Q1 2013. Even with its equity losses due to Agency RMBS investments, it only lost -$0.15 in book value in Q1 2013. In fact if it had not recorded a special $0.50 per common share dividend in March 2013, it would have had a book value gain of +$0.35 per share in Q1 2013. This sharply contrasts with both AGNC, which had a -$2.71 book value loss (-8.6%) in Q1 2013, and WMC, which had a -$2.25 book value loss (-10.4%) in Q1 2013.

Looking forward, the Q2 book value losses for primarily Agency RMBS investing mortgage REITs such as AGNC and WMC promise to be much worse than they were in Q1 2013. The average Freddie Mac mortgage rate for 30-year fixed loans in December 2012 was 3.34%. The average rate for March 2013 was 3.55%. In other words there was approximately a +21 bps gain in 30-year fixed rate Freddie Mac mortgage rates during Q1. For the last three days (June 24-26, 2013) the 30-year fixed rate Freddie Mac mortgage has averaged 4.67% nationally. This is a full 112 bps above the March 2013 average. Yes, AGNC, WMC and others do have hedging strategies, but these are unlikely to come close to covering their Q2 2013 book value losses, especially when the 30-year US Treasury bond yield had only risen about 48 bps from March 29, 2013 through June 26, 2013.

Many hedging strategies are based on US bond yield movements, which are generally expected to parallel the mortgage rate rises. This has not been the case in the recent run up (a 112 bps 30-year fixed Freddie Mac mortgage rate change versus a 48 bps 30-year Treasury Bond yield change). Hence one would expect many of the mortgage rate increase related losses to be uncovered by US Treasury Bond yield hedges (or European bond yield hedges). Further most hedging strategies are only designed to cover from 50% to 70% of the book value losses even in the best case scenario. In the above scenario, the coverage of book value losses is likely to be much lower.

MFA only has to worry about such losses on 25% of its net equity. Plus it gets to have gains from its non-Agency portfolio. MFA's non-Agency portfolio gains for March 2013 alone (one month) were 692 bps. I am sure MFA would not want to claim such gains will occur every month. However, the residential real estate market has been improving. The Case-Shiller 20-city Index was up 12.1% year over year for April 2013. This kind of gain helps all of MFA's non-Agency RMBS holdings to gain value. Since they are currently at about 73% of par, they have a lot of possible fair value to gain. MFA's non-Agency RMBS portfolio constitutes about 67% of MFA's allocated equity. Plus that 67% is leveraged 1.48x. With likely big book value gains, the non-Agency portfolio should be able to significantly offset the likely Agency portfolio book value losses for MFA. Thus MFA should be able to gain huge net interest spread increases on its Agency portfolio assets in Q2 without huge losses. These net interest spread gains should leave it in a position to raise its dividend in Q3 -- perhaps by a lot.

The following table gives MFA's portfolio allocation as of March 31, 2013.

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The chart below shows MFA's total return since January 2000. This return of 727.8% through March 31, 2013, far exceeds the less than 50% return of the S&P 500.

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The annual total return on average was 17.3% per year. This far exceeds most investments and it makes MFA a buy in these troubled times. When you consider MFA's relative safety compared to primarily Agency RMBS investing mortgage REITs, it is doubly a buy.

The two-year chart of MFA provides some technical direction for this trade.

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The slow stochastic sub chart shows that MFA is near oversold levels. The main chart shows that MFA is far below its 200-day SMA and its 50-day SMA. Since its 50-day SMA is still significantly above its 200-day SMA, it is not yet in a downtrend and its stock price is likely to bounce upward significantly from current levels.

Its book value per share of $8.84 per common share as of March 31, 2013, is above the current stock price of $8.33 per share by about 6.1%. Since MFA had effective book value gains of $0.35 per share in Q1 if you excluded its special $0.50 dividend, one is inclined to think it will have low or no book value losses in Q2 2013.

A significant Agency portfolio net interest spread increase in Q2 (a substantial increase in net interest income or distributable income) then makes MFA extremely attractive. Even without increasing its dividend, which seems a sure thing later in 2013, MFA is set to pay approximately a 16.5% dividend in 2013 (including the $0.50 per common share special dividend). It now seems that MFA is more likely to pay a FY2013 dividend that is closer to 20%. This makes it look much more attractive than the 20% dividend paying primarily Agency RMBS investing mortgage REITs that seem likely to lose more than -10% of their book value in Q2 2013 alone (after a roughly -10% book value loss in Q1 2013). In fact some may lose as much as -30% of their book value in Q2 alone. This last is hard to calculate exactly without more information and without the quarter actually having ended yet. Still even in the best scenario for the primarily Agency RMBS mortgage REITs, MFA seems to come out far ahead in comparison to primarily Agency investors like AGNC and WMC.

MFA is a buy. It has a mean analysts' recommendation of 2.4 (a low buy) and it has a CAPS rating of five stars (a strong buy). If there is a double dip US recession, it will have trouble along with most stocks. However, it is hard to argue with its record of success since January 2000. Its diversification is a big strength in these uncertain times.

NOTE: Some of the fundamental financial data above is from Yahoo Finance.

Good Luck Trading.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in MFA over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.